Automatic 401(k) Saving Features No Fail-Safe to Retirement Success

A growing number of employers are adding automatic features to
these workplace retirement-savings vehicles, typically sweeping new
hires into the plans and setting workers' contributions at 3% of
pay.

Workers can always opt out of the auto-saving features, but they
usually don't--and their willingness to put savings on autopilot is
both good and bad news. On the plus side, automation leads many who
would otherwise save nothing to steadily sock away a slice of their
paycheck. But the 3% default contribution rate favored by employers
doesn't come close to the savings rate needed for a secure
retirement: roughly 12% to 15%, experts say, including both worker
and employer contributions. A 3% contribution isn't even enough to
get the typical employer's full 401(k) matching contribution,
meaning many workers are skipping the only free money they'll ever
see.

Employers' embrace of the 3% default gets more troubling when
you quantify the benefits that could come with smarter automatic
features. The Employee Benefit Research Institute recently looked
at the potential impact on workers' retirement success rates if
plans that automatically enroll workers and increase participant
contributions annually were to boost their initial default
contribution rate to 6%. (EBRI defined retirement "success" as a
401(k) balance that, when combined with Social Security benefits,
replaces 80% of preretirement income after adjusting for inflation.
The study focused on younger workers with at least 30 years of
401(k) eligibility. EBRI assumed that workers' opt-out rates would
remain stable and that workers would start over at the default
contribution rate when changing jobs.)

The results: The simple jump to a 6% default contribution
produced striking improvements in retirement success rates for
workers across the income spectrum. With the higher default
contribution, nearly three out of four workers in the lowest income
quartile would be on the path to a secure retirement, EBRI
projects, compared with just 62% under current default contribution
rates. That means that more than a fourth of the workers previously
on a collision course with retirement mayhem would have a brighter
future.

Even the highest-income workers would see a substantial benefit.
Nearly 20% of those currently not saving enough would see
retirement success with a 6% initial default contribution, EBRI
projects.

While some employers have adopted the 6% solution, they're
exceedingly rare. About 46% of plans automatically enroll workers,
according to the Plan Sponsor Council of America, a group for
employers offering retirement plans. Just 11% of those
auto-enrollment plans set the default contribution at 6% or higher.
Nearly seven out of ten set the default at 3% or less. And though
most auto-enrollment plans also offer to automatically increase
workers' contributions annually, nearly 80% of these plans cap the
auto-increases at 6% of pay or less, according to PSCA.

Budging from the 3% Default Rate

Given what's at stake, it's tough to find a satisfactory
explanation for the 3% default's popularity. The most commonly
cited employer objections to boosting default contribution rates
hardly seem insurmountable--and some seem disconnected from
reality. Some retirement experts point to an old IRS ruling that
used a 3% default in an example of an auto-enrollment plan that
would pass regulatory muster. But there's really no legal barrier
for employers to choose higher default rates, experts say. "It's
not that the IRS ever said, 'if you go above 3%, you're in
trouble,' " says Jack VanDerhei, research director at EBRI.

Another employer objection: "Some plan sponsors believe their
employees can't afford higher savings rates," says Jean Young,
senior research analyst at Vanguard Center for Retirement Research.
"We can show them that's actually not the case." Vanguard's
research suggests that workers' 401(k) opt-out rates don't change
with the level of the default contribution rate. In fact, it has
found that workers earning less than $30,000 contribute 50% more,
on average, when left to their own devices in totally voluntary
401(k) plans than in automatic-enrollment plans where employers set
the default contribution.

A third employer objection: "Cost is always an issue," says Bob
Benish, PSCA's executive director. The most common employer
matching contribution is 50 cents on the dollar up to the first 6%
of pay, Benish says. If plans boost the default contribution to 6%,
far more employees would collect the full employer match--taking
more money out of the company's pocket. But employers could
restructure the match so that the higher default rate would cost
them little or nothing--and simultaneously give workers a great
incentive to save more. An employer that previously matched worker
contributions dollar for dollar up to 4% of pay, for example, could
instead match 50 cents on the dollar up to 8% of pay.

Asking participants to double their savings rate to get the same
employer matching contribution may not draw cheers from many
workers--but ultimately, neither will 401(k) plan designs that
leave retirees struggling to make ends meet.

While research piles up in support of higher default
contribution rates, workers shouldn't wait around for employers to
rethink their 401(k) plans. Seize control: Contribute at least
enough to get the full employer matching contribution, and work
toward the 12% to 15% total savings rate that retirement experts
recommend. You may not get there overnight--but you won't be asleep
at the wheel while your savings putter along in the slow lane.